The purpose of this paper is to test the smooth adjustment hypothesis by using panel technique for Iran's manufacturing industries at the 4-digit aggregation level of ISIC classification, during time period 2001-2006. According to the smooth adjustment hypothesis, intra-industry trade expansion entails lower adjustment costs than inter-industry one. In this paper, by distinguishing marginal intra industry trade to its horizontal and vertical types and employing the total reallocation effect as a proxy of the adjustment cost of reallocation between sectors and occupations, we’ve tested smooth adjustment hypothesis for both marginal intra industry trade and its types. So, comparing with other empirical studies, this paper has used marginal vertical and horizontal intra industry trade as well as marginal intra industry trade to test the hypothesis. The obtained results do not support the hypothesis for marginal intra industry trade. On the other hand, by distinguishing marginal intra industry trade to marginal horizontal and vertical intra-industry trade, this hypothesis is expectedly confirmed. This result is justifiable since marginal horizontal intra industry trade is a change of intra industry trade with similar factor intensity whereas marginal vertical intra industry trade is mainly based on differences in factor endowment.
